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Design Risk for Contractors and CMs: How Insurance Addresses the Exposure
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November 30, 2009
By Jeffrey R. Gans and Stephen D. Palley
The great modern architect Mies van der Rohe reportedly said that “architecture starts when you carefully put two bricks together.” Of course, this begs the question of who will physically put the bricks together. Surely, van der Rohe did not mean to suggest it would be the architect. Such things are left to a contractor, who is to follow the architect’s design, subject to many decisions about construction “means and methods.” And, were the bricks to fall, the architect likely would place blame squarely on the contractor, who no doubt would find fault with the architect’s design. This is a fight familiar to many in the construction industry.
Whether “design” or “construction means and methods” are at issue in a claim or suit may significantly impact available insurance coverage. Contractor and construction manager participation in project design may blur already-difficult-to-discern distinctions between the design and construction teams. This is the case whether a project is built using traditional design-bid-build or design-build approaches or hybrids involving design-delegation or design-assistance. The confusion can be compounded by developing technologies such as building information modeling or BIM. In all such cases, early evaluation of the relationship between the project delivery mechanism and available insurance coverage is critical for effective risk transfer to take place. In this connection, an often overlooked consideration is the role of commercial general liability (CGL) insurance when a claim or suit directly or indirectly implicates construction design, whether as an incidental or core component of the construction team’s service.
Construction Project Delivery Methodology
Three basic delivery methods are used for most construction projects. Each method implicates different project risks for contractors, and within each method, means and methods and design function may overlap. One distinguishing factor in each approach is the level of the contractor’s involvement during the design phase.
 | Design-Bid-Build |
On a design-bid-build project, the owner’s design team prepares documents suitable for construction. The “ready for construction” documents are put out for bid. A contractor performs the work designed by the owner’s design team although to do so the contractor may prepare more detailed construction and coordination drawings, and subcontractors, fabricators and material suppliers typically provide shop drawings showing details not present in the A/E’s design drawings.
In theory, the line between construction and design is clearly delineated in a design-bid-build project. In practice, however, the distinction may be blurred. This may be the case, for example, if the construction team is provided a performance specification instead of a design specification for a project or parts of it. Depending on contractual agreements and state and local laws regarding professional services, the contractor may take on certain responsibilities in addition to providing traditional construction services. Whether or not this constitutes “professional services” must be evaluated on a case-by-case basis, but this evaluation may have significant insurance implications, as discussed below.
| Design-Build |
In contrast to a design-bid-build project, when design-build is used, “the owner contracts with a single entity, often a joint venture, to design and construct the project. The owner identifies its basic needs and requirements for the project and prepares a request for proposal. The bidding designer-builders then develop proposals to be evaluated by the owner for quality of the design and price. After the design-builder is chosen, the design phase is completed by development of the construction drawings. Thereafter, the design-builder is responsible for selecting the materials, means and methods to produce the final project that meets owner expectations.” 1/ Design-build also is referred to as EPC (engineer, procure, construct) contracting, particularly in connection with industrial facilities and power plants.
Design-bid-build projects sometimes have design-build aspects, for example as when the general contractor subcontracts for certain project components, such as electrical, plumbing or HVAC, on a design-build basis. 2/
| Construction Management |
The owner also may contract with a construction manager (CM), which may have a role in either a design-bid-build or design-build project. The CM may be at risk and hold some or all of the direct construction contracts for a project. It also may have a contractual obligation to deliver the project on time and budget. Under an agency CM agreement, the owner will hold the construction contracts, and the CM will act as the owner’s representative in supervising those contracts, with the extent of its supervisory responsibility governed by the contract between the owner and the CM.
A construction law treatise summarizes the distinction between a CM, general contractor, architect and engineer as follows: “The array of services usually available for the construction manager to perform are the non-design functions of the architect and engineer and the non-construction activities of the general contractor. It is not uncommon to encounter construction managers performing such customary design professional services as cost estimating and contract administration. Nor is it unusual for construction managers to perform such customary general contractor functions as coordination and scheduling of the work.” 3/
Building Information Modeling
The line between construction and design may be further blurred through the use of interactive computer modeling systems in the development of design documents. One such approach is Building Information Modeling or BIM, in which an electronic building model is made available to all project participants. It allows on-the-fly exchange of information, design refinement, coordination and development between the design team, CM and contractors of all tiers before and during construction process. 4/ BIM allows project participants to review, comment on, detail and change design and construction drawings. “Subcontractors, such as those for steel structures, precast concrete and cast-in-place concrete, façade and curtainwall fabricators, would all use the Building Information Model for detailing and shop production, with the general contractor using the various BIM models to coordinate all specialties.” 5/
BIM is praised for efficiencies it creates in communication about project scope, design, schedule and cost. However, this same communication may unwittingly draw non-design professionals into decisions having design components.
How Standard CGL Policies Address ‘Design’ Risk
Typically, the smallest “bucket” of insurance for design-related risks is the architect’s and engineer’s errors and omissions policies, which often have low and “wasting” policy limits and are written on claims-made forms. These policies also typically contain exclusions for claims arising out of “construction means and methods.” The same may be true of construction manager professional liability insurance that a CM may obtain to cover claims related to or arising solely out of construction management supervisory services. In contrast, in connection with a typical construction-related claim or suit, CGL insurance (in combination with excess and umbrella insurance) often provides the highest available limits of liability. Thus, it is critical third party liability coverage for any construction project.
Trade contractors and construction managers usually provide commercial general liability insurance to address property damage or bodily injury caused by “occurrences” arising out of their work, whether during the course of construction or after construction operations are completed. 6/ Whether coverage is provided by an individual policy or by a project policy, whether an OCIP (owner-controlled insurance program), CCIP (contractor-controlled) or otherwise, some version of the standard ISO CGL occurrence policy form generally will be used and may in fact be specified and required by contract documents. 7/
The base ISO CGL occurrence form does not exclude coverage for claims or suits arising out of professional services. 8/ However, and particularly in the construction context, this coverage often is excluded by the addition of exclusionary endorsements. Several ISO endorsements are used by underwriters to address “professional services” and attendant design risks.
Before the decision in Harbor Insurance Co. v. Omni Construction 9/, the standard professional services exclusion on contractor CGL policies was provided on ISO form CG 22 43, which excludes from coverage bodily injury or property damage “arising out of the rendering or the failure to render any professional services by or for the named insured, including 1. The preparation or approval of maps, plans, opinions, reports, surveys, designs or specifications and 2. Supervisory, inspection or engineering services.” 10/
At issue in Harbor was the impact of prime contractor Omni’s subcontracted sheeting and shoring work on an adjacent property owner, which claimed that excavation resulted in settlement to its building. Although presented with evidence that sheeting and shoring is an accepted component of a contractor’s “construction means and methods,” the court held that design of this system constituted a “professional service” and that no coverage would apply because “the loss was caused by the rendition of professional services, viz., the engineering of the sheeting and shoring system.” 11/
Following the Harbor decision, ISO issued a new professional services exclusion, CG 22 79, with the direction that this (as opposed to the CG 22 43) be used for construction contractors. CG 22 79 contains the following clarification in its final section: “Professional services do not include services within construction means, methods, techniques, sequences and procedures employed by you in connection with your operations in your capacity as a construction contractor.” Thus, incidental design services (preparing or reviewing shop drawings, for example) are not excluded by CG 22 79 when provided by a covered construction contractor. 12/
ISO also issued the CG 22 80 endorsement, which is less restrictive than the CG 22 79, because it contains the following concluding caveat: “This insurance does not apply to ‘bodily injury,’ ‘property damage,’ ‘personal injury’ or ‘advertising injury’ arising out of the rendering of or failure to render any professional services by you, but only with respect to your providing engineering, architectural or surveying services in your capacity as an engineer, architect or surveyor.… This exclusion does not apply to your operations in connection with construction work performed by you or on your behalf.” In other words, as long as the insured contractor is performing construction work, the fact that this work includes a design component – whether incidental or broader – the exclusion does not apply. Thus, the exclusion is the least restrictive form of the ISO professional services exclusion (and typically recommended for use in the design-build context). 13/
In addition, ISO endorsement CG 22 34 excludes coverage for, among other things, “[i]nspection, supervision, quality control, architectural or engineering activities done by or for you on a project on which you serve as construction manager.” However, the exclusion is followed by an exception providing that the CM retains coverage for “construction or demolition work” performed by or for the CM, its employees or its subcontractors.
Taking Time to Fill the Gaps
There can be no “one size fits all” rule to determine where design ends and construction begins. The choice of project delivery mechanism, jurisdiction where a project is located, and the parties’ course of conduct and practice during construction all impact this analysis. Consequently, it is critical at the beginning of an individual construction project for project stakeholders to frankly assess how project risks are being allocated and to determine whether a construction team’s role in the design process is backed up by proper insurance coverage.
Which ISO endorsement is attached to a CGL policy form can be significant in the event of a claim. As part of a front-end analysis of potential design risk, careful attention must be paid to the CGL policy form and the selected ISO professional services endorsement, if one is used. In the event that the CGL coverage is insufficient, specialty coverage such as contractor’s professional protective insurance (“CPPI”) 14/ or construction manager professional liability insurance may be available to pick up contractor or construction manager design and other professional risk outside traditional coverage scopes. 15/
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ENDNOTES
| 1/ | Walter J. Sears and Arlan D. Lewis, Risk Management in Design-Build, Practicing Law Institute (May 1999) [PLI Order No. N0-002D: “Handling Construction Risks 1999: Allocate Now or Litigate Later”].
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| 2/ | See, e.g., AIA A201 §3.12.10 (2007).
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| 3/ | 5 Bruner and O'Connor on Construction Law §16:15 (2008), cited in The Fifth Day, LLC v. Bolotin, 172 Cal.App.4th 939, 955, 91 Cal.Rptr.3d 633 (2009).
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| 4/ | See generally, Chuck Eastman, BIM Handbook: A Guide to Building Information Modeling for Owners, Managers, Designers, Engineers and Contractors (John Wiley & Sons 2008). As noted in a General Services Administration report: “BIM is a data rich digital representation cataloging the physical and functional characteristics of design and construction. It can serve as a shared knowledge base that is directly manipulated (computable). Its importance stems from having an open interchange of information across platforms and a transferable record of building information throughout a building lifecycle. BIM serves as a reliable foundation for decision making and provides a platform for automated analyses that can assist in planning, design, construction, operation, and maintenance activities.” GSA BIM Guide Series 01, at 4, available at www.gsa.gov/graphics/pbs/
GSA_BIM_Guide_v0_60_
Series01_Overview_05_14_07.pdf (last visited July 14, 2009).
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| 5/ | Charles Eastman, Ghang Lee and Rafael Sacks, Development of a Knowledge-Rich CAD System for the North American Precast Concrete Industry (2003), available at bim.arch.gatech.edu/
data/reference/
Development%20of%20a%20knowledge-rich
%20CAD%20system%20for%20the%20
North%20American%20precast%20
concrete%20industry_acadia03.pdf (last visited January 13, 2009).
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| 6/ | This is set forth in form contracts used by the construction industry, AIA A201 §11.1.2 (2007); ConsensusDOCS 200 §10.2.1 (2009). See also, FAR Subpart 28.307-2. The 2007 version of A201 introduces some changes to the insurance provisions in Article 11. Of particular note to this discussion is a requirement that architects be listed as additional insureds on the general contractor’s insurance policies. This coverage surely is intended to be limited to claims against the architect arising out the contractor’s non-design-related construction means and methods. CGL underwriters may be reluctant to add A/Es to a general liability policy form as additional insureds, and as a result, there may be pushback when this is requested. An ISO form is available to provide this coverage although it may not be an ideal solution.
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| 7/ | The 2007 version of CG 00 01 is the latest iteration of the form.
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| 8/ | But see, Definition of Insured Contract, Part f in CG 00 01 (2007). See also, II Construction Risk Management, §§VI.C.8 and 9 (International Risk Management Institute, 10th rev. 2007).
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| 9/ | 912 F.2d 1520 (D.C. Cir. 1990).
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| 10/ | Harbor, 912 F.2d at 1525.
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| 11/ | Id. See also, State Farm v. Habitat Construction Co., 377 Ill.App.3d 281, 875 N.E.2d 1159 (2007) (professional services exclusion inapplicable to general contractor who was “not an architect, engineer, or supervisor [where the plaintiff’s] Complaint [did] not allege otherwise”). Cf., Cowell v. Gaston County, 190 N.C.App. 743, 660 S.E.2d 915 (2008) (by its plain terms, exclusion applied only to engineers, architects or surveyors). But see, Noyes v. Canadian Indemnity Co., 487 F.Supp. 433 (D.Colo. 1980) (professional services exclusion did not apply to damage alleged to have arisen out of insured’s consulting services in connection with oil and gas well construction and maintenance when the services at issue were not provided by a “professional” under applicable state law); Aetna Fire Underwriters Insurance Co. v. Southwestern Engineering Co., 626 S.W.2d 99 (Tex.App. 1981) (“engineering services” as used in definition of “professional services” in CG 22 43 is ambiguous, and the ambiguity is to be construed against the insurance company).
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| 12/ | The ConsensusDOCs 200 series Standard Agreement and General Conditions Between Owner and Contractor at §3.15 provides that a contractor “may be required to procure professional services in order to carry out its responsibilities for construction means, methods, techniques, sequences and procedures for such services specifically called for by the Contract Documents.” Use of such language may weigh in favor of the CG 22 79 or CG 22 80 endorsements when professional services exclusions are used.
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| 13/ | II Construction Risk Management, §VIII.E.5 (International Risk Management Institute, 10th rev. 2007).
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| 14/ | Several insurers offer CPPI coverage, which can serve as a form of difference in conditions/excess coverage for certain professional liability claims that may be made against contractors. For example, the Zurich “Contractor’s Protective Professional Indemnity and Liability Insurance” policy form includes coverage for “all sums in excess of the applicable Self Insured Retention…. that the ‘Insured’ is legally obligated to pay as ‘Damages’ because of a ‘Professional Liability Claim’ first made against the ‘Insured’ during the ‘Policy Period’ and reported to us during the ‘Policy Period’, the Automatic Extended Reporting Period or the Optional Extended Reporting Period if applicable.” The policy form also provides that the insurer will “indemnify you for ‘Losses’ in excess of the ‘Design Professional's Insurance’, subject to the provisions of the Self Insured Retention and Limit of Liability designated in…. the Declarations.” Factors in determining the utility of such a policy include available limits, premium, and the nature and amount of self-insured retentions and deductibles. The policy (at least in its specimen form) contains an exclusion applicable to “ ‘Bodily Injury’ or ‘Property Damage’ arising out of construction means, methods, techniques, sequences and procedures, site safety, crane erection, use, maintenance or operation; scaffolding; any temporary structure; project fencing; or cleanup or demolition….”
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